How Barnes & Noble Destroyed Itself

It's no secret that Barnes & Noble (NYSE: BKS  ) is in trouble. Faced with the unrelenting onslaught of competition from the likes of Amazon.com (Nasdaq: AMZN  ) and Apple (Nasdaq: AAPL  ) -- which coincidentally is rumored to have developed a 7-inch tablet more directly competitive with B&N's Nook -- I don't think it's much of an exaggeration to say that the bookseller's days are numbered.

While most of the reasons for B&N's ongoing decline are well known, there's one primary contributing factor that isn't as commonly discussed. I came across a chart the other day which illustrates this point extremely well. But before getting to it, let's briefly retrace the combination of variables that left the former giant so vulnerable.

An unnecessary tragedy
What makes B&N's story tragic from a shareholder's and book-lover's perspective is that it wasn't inevitable. The company would be in an entirely different position if its leadership hadn't pooh-poohed online retail in the late 1990s, when the now-dominant Amazon was in its infancy. Consider this from its 1998 annual report: "Although it is clear the World Wide Web, with its profound possibilities, will become a major component of the future of bookselling and publishing, we believe retail bookstores will remain the foundation of our industry . . . shopping and browsing in a bookstore is an irreplaceable experience, and it is woven securely into the fabric of our American culture [emphasis added]."

It'd also be in a different position if it hadn't procrastinated in the digital book arena, releasing the underwhelming Nook a full two years after Amazon had released the Kindle. By that time an estimated 1 million Kindles were being sold each year, tethering droves of current and future customers to Amazon. And it even didn't seek the committed help of a big-name tech company until earlier this year, when it announced a partnership with Microsoft (Nasdaq: MSFT  ) a mere two months before Google (Nasdaq: GOOG  ) jumped into the tablet wars as well with its own 7-inch Nexus 7.

B&N also didn't help its cause by wasting over a billion dollars on share buybacks on the eve of the financial crisis. Just over three years ago, its management boasted about repurchasing a staggering 33 million shares for a total cost of $1 billion. That equates to an average of $30 per share, more than double the $13 that they're trading for today. In retrospect, it was a shocking and colossal waste of money.

An inexcusable act
Of course, absent the benefit of hindsight, these mistakes are arguably excusable as failures in business judgment or as the natural consequence of Joseph Schumpeter's "creative destruction" or Clayton Christensen's "innovator's dilemma." They're the result of negligence and not premeditation; financial manslaughter and not murder.

But with the company now running out of cash and hurtling toward insolvency, and even without the benefit of hindsight, there's one wound that the company unnecessarily and egregiously inflicted upon itself that can't be so innocently dismissed.

In 2009, the company paid its chairman of the board, Len Riggio, nearly $600 million for B&N College, an amalgamation of campus-based bookstores that controlled the rights to the parent company's trade name and was then owned by Riggio and his wife.

At the time, it looked like a classic covetous overreach by an executive to extract capital without selling shares. When all that's left of B&N is a Harvard case study, however, my guess is that this blatant display of avarice and disregard for minority shareholders will be characterized more ominously as the proverbial straw that broke the camel's back.

BKS Tangible Book Value Chart

BKS Tangible Book Value data by YCharts

As you can see above, the insider transaction wasn't a mere peripheral occurrence. It fundamentally transformed B&N from a company with a so-called fortress balance sheet into a company with a negative tangible book value. In May of that year, B&N had no debt whatsoever on its balance sheet. But by October, notably following the transaction, a whopping $325 million in long-term debt and hundreds of millions more in liabilities magically appeared. And to make matters worse, these additions were counterbalanced with little more than $700 million in goodwill and other intangible assets.

The lesson to be learned here
Even though this might strike some as old news, the lesson to be learned here is timeless and invaluable to investors. Quite simply, be wary of large insider transactions, and particularly so when they serve in lieu of a stock sale and/or are accompanied by the appearance of impropriety. Indeed, there is no clearer sign that it's time for you to sell as well.

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Fool contributor John Maxfield's 401(k) owns shares of Barnes and Noble. The Motley Fool owns shares of Microsoft, Google, Apple, and Amazon.com. Motley Fool newsletter services have recommended buying shares of Amazon.com, Google, Microsoft, and Apple. Motley Fool newsletter services have recommended creating a bull call spread position in Apple, creating a synthetic covered call position in Microsoft, and writing puts on Barnes & Noble. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (5) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 15, 2012, at 4:22 PM, deemery wrote:

    Unfortunately investor lawsuits only benefit the lawyers. Otherwise, this situation would look ripe for a lawsuit on Board of Director breach of fiduciary responsibility.

    My problem with B&N is they continue to move away from their primary mission of selling books. Our local B&N is now about 50% not-books, including a lot of wasted open space to sell Nook hardware, a section on records that doesn't have enough stock to be interesting (and can't compete with WalMart on prices for popular items) and recently expensive toys.

    Borders' strength was stockage; they carried books that B&N didn't. And their website allowed you to check the local stores for books in stock. B&N hasn't caught up to that yet.

    So maybe if B&N concentrated on selling books with a combination of brick-and-mortar stockage, support for browsing, and internet presence that supports out-of-store fulfillment, that should be a viable business model.

  • Report this Comment On August 15, 2012, at 6:18 PM, XMFDivine wrote:

    @deemery

    Good points all. It seems that if B&N's former competition--which can be argued to have actually executed the core competency of selling books more efficiently--has already failed miserably and gone out of business, then B&N is dead meat.

    B&N's not going to get anywhere playing catch-up. Amazon especially sealed ol' B&N's fate years ago, I'm afraid.

    For personal reasons, I hope small mom-and-pop bookstores don't disappear entirely...

  • Report this Comment On August 15, 2012, at 7:00 PM, foolindeed1 wrote:

    Yet another Amazon-paid infomercial on Fool's site - no surprise here. Nook price was cut to lead the way for the new models and of course Fools think that's the sign of weakness. Microsoft investing over 600 mil into combination of Nook and College - but of course Fools see it not as a long term strategy and the reason behind the College purchase but a sign of wrong-doing by the management.

    Nook’s are still the only devices that provide microSD slots for adding up to 32GB of space while Nexus, Fire, iPad still box you into non-expandable memory/space to force you to pay for their Cloud space beyond free 5GB.

    Now 16GB Nook Tablet (dual-core CPU and 1GB RAM) costs $50 less than both 16GB Nexis and Fire and has 30% more battery life than both.

    I believe that it’s the best value for you money on the market now that the price dropped. Dual-core CPU is great for playing movies, you don’t need quad-core CPU of Nexus for it and you pay with battery life for extra (not needed) horse powers.

    B&N has nearly 30% of eBook market and has been 1 step ahead of Amazon for the past 2 years with Nook Color, Nook Touch and now Nook Touch with light. Hardly "near collapse"...

  • Report this Comment On August 15, 2012, at 11:39 PM, shadowgal wrote:

    foolindeed1 wrote, "yet another Amazon-paid infomercial on Fool's site-no surprise here." That's a pretty serious charge you just made, still waiting for some evidence to back it up. Putting that silliness aside, good article, all good points. One item you overlooked, the recent news of BKS CEO William Lynch hauling in a 10 million dollar bonus! All while the company is losing money and is more than likely a sinking ship. I'm glad I no longer own any BKS stock.

  • Report this Comment On August 16, 2012, at 7:25 AM, foolindeed1 wrote:

    @shadowgal

    Disclamer: " The Motley Fool owns shares of Microsoft, Google, Apple, and Amazon.com. Motley Fool newsletter services have recommended buying shares of Amazon.com, Google, Microsoft, and Apple. Motley Fool newsletter services have recommended creating a bull call spread position in Apple, creating a synthetic covered call position in Microsoft, and writing puts on Barnes & Noble. "

    Enough said...

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